When Fiona Wilson looks ahead, she sees a bright future. A portfolio manager on the systematics strategy team at Guardian Capital has forecast a stock picker’s market for the next 12 months, which is great news for her profession.

“There have been some stocks that don’t have good balance sheets, [but] with very high P/E ratios that have done well. So I think we’re going to see some single stock dispersion in the next year.”

Also, she expects firms that don’t currently pay dividends to start doing so because there’s a lot of cash on balance sheets, and investors are demanding distributions.

“With demographics changing and more people reaching retirement, they’ll want dividend companies. So, a lot of stocks we’ve been purchasing recently have been strong dividend growers.” When crafting portfolios, she uses a Growth, Payout, Sustainability (GPS) strategy.

How does this work?

We don’t make macro calls because we’re top down, sector diversified. Within each sector we’re looking for the best companies. To do this, we use a quantitative model that narrows down the global universe, which has more than 3,000 stocks, to about 150 stocks.

The model evaluates these companies based on fundamentals including growth, cash flow and earnings. Our team uses various risk parameters and weightings for each sector, based on 30 years of back testing, and builds portfolios.

And how do you divide stocks?

We categorize companies into three groups, each of which pays dividends.

  1. Dividend payers have stable cash flow, modest dividend growth and high yield (e.g., telco and utilities companies)
  2. Dividend growers have good cash flow and low to medium yield. McDonald’s falls into this group. It’s up about 21% compared to the consumer discretionary index, which is up 45% year-to-date. But the company has lower volatility and a strong five-year dividend growth rate of 9%. They also have a long-term, competitive position in the marketplace with the launch of their McCafé beverages.
  3. Dividend achievers are more cyclical and have lower dividend yields. Examples include Emerson Electric, a Missouri-based multinational manufacturer and BASF, a German-based chemical company. Cash flow is reinvested for growth.

Also, we’re not looking for one big winner. A lot of our alpha comes from industry dispersion. If we see three companies in the same industry come up as a strong buy, we prefer to go 1% for each, as opposed to one company at 3% or 4%.

The most we hold is 5% in one company because we’re going for a diversified portfolio approach. So, often, we’ll go in at 1% and let it ride to 5%. Then we start trimming, and the profit will either go into a new buy, or a position that had a smaller weight.

What sectors have caught your eye?

A lot of American IT companies have become leaner in the last five years and have more cash on their balance sheets. They’re starting to pay dividends, which is good because we can have larger benchmark weightings. For instance, when Apple started to pay a dividend, it came up as a buy in our model. Its dividend yield is 2.1%, and it’s got good growth.

You’re looking for global dividend growth companies. Why?

Over the last 40 years, more than 50% of returns have come from global dividends. In Australia, returns have been 73%; Germany 58%; Hong Kong 69%; and the U.K. 74%. So it’s a really good way to access different sectors.

What’s your recent best move?

Once Fed taper talk started in May 2013, the volatility in the bond market increased. So from May 2013 until August 2013, we decreased portfolio sensitivity to interest rates. We sold stocks, like U.S. REITs, and increased our dividend growth weight in the portfolio. This worked in our favour.

What markets are the wildcards?

Emerging markets have high volatility. As a result, we’ve seen a lot of outflows. We usually weight up to 15%. Right now we’re about 2.5%, depending on the portfolio. The risk-reward tradeoff isn’t there, so we aren’t seeing many emerging markets come up as buys in our model. If you see interest rates continue to rise, there could be even more outflows. Japan is also volatile, so we’re significantly underweight. Companies simply don’t have dividend yield and, until this changes, we’ll continue being underweight. Also, the Eurozone needs to experience growth before it can make a comeback. But in the last six months, we’ve started to see some attractive companies, particularly those that export to the U.S., like car manufacturers, as well as European insurance companies.

Are you hedged or unhedged?

Right now, we’re comfortable being unhedged because of the weakening Canadian dollar and strengthening U.S. dollar.

What’s your cash limit?

The most we can hold is 10%, but we usually keep less than 5%.

Suzanne Sharma is the associate managing editor of Advisor Group.

Originally published in Advisor's Edge Report

Read this article and full issues on the iPad - click here.

Add a comment

You must be logged in to comment.

Register on Advisor.ca